11/7

FUZZY MATH

Fuzzy Math...It's beginning to smell a lot like stagflation.  It's not just in corporate earnings that we are seeing cost pressures bubble up from below and top line pressures exert force from above.  The economic numbers in general are reflecting a new shade of blue.  The recent September/October economic numbers don't reflect a plethora of holiday cheer.  At least not yet:

As you know, these numbers characterize the joint forces of slowing economic growth and rising inflationary pressures.  There's nothing fuzzy in the numbers of the above table.  In fact the message is crystal clear.  

To think that the stock market has made a serious or meaningful bottom in this type of an economic environment appears to be wishful thinking.  At least the last time we checked, stagflation was anything but bullish for stock valuations.  Particularly noteworthy in the statistics above was the average hourly earnings number put out late last week.  Wage gains were widespread.  The bulls pointed to a decline in hours worked as fresh evidence of hoped for soft landing economic slowing.  Alternatively, the rise in earnings displayed strength in compensation on top of shorter hours worked.  Compensation increased at a 6.4% annualized rate - the highest number in more than 8 years.  For the moment, the bet has to be that the Fed won't even go as far as changing its tightening bias at the upcoming meeting on the 15th.  Not without a sharp decline in stock prices or very soft economic numbers in the interim.

Consumption Junction...We believe that one of the key questions for the economy over the near term is whether the US consumer will ride to the rescue.  In the last few years, the consumer has shown up on cue in 4Q to lift holiday spirits of the general economy.  Of course these were also periods where Club Fed was priming the monetary pump.  Plenty of money for consumer spending (including stocks).  Interestingly enough, strong 4Q consumer spending also led to strong spending in the first quarter of the subsequent year.  Here are the numbers:

Will it be so again in 4Q 2000 and possibly into early 2001?  Interestingly since the 1Q high in the equity markets for 2000, year over year percentage change in chain store sales has been trending down as you can see:

The drop from April to June, the subsequent plateauing and the second significant drop into October seems to strongly suggest that chain store sales have a certain correlation with the equity markets.  Surprise, surprise.  As a corollary to previous data regarding consumer spending in 4Q and 1Q periods above is the following:

As is plainly obvious, once nasty October was out of the way in the last five years, the 4Q equity holiday party began.  No sense waiting until Christmas to unwrap these speculative presents.  Once again, the experience of the last three years was also accompanied by liquidity refreshments.  Was it the stock market that drove consumer spending?  Was it monetary ease that drove them both?  Was credit driven consumer spending the driver of stock prices as retail earnings and revenues picked up seasonally?  Our logic dictates that these relationships are interdependent.  They feed off of and reinforce each other.  

This year may just be the exception to the rule of the last five.  Although the Fed is anything but restrictive, massively excessive monetary juice is not being unleashed at the moment.  Likewise the equity markets have dealt players a mediocre hand over the course of the year.  October consumer confidence numbers displayed one of the larger one month drops in a while skidding from 142.5 to 135.2.  Of course the last few months of market action have been anything but reassuring.  Given the importance of the consumer to the US economy, we believe it will be quite important to watch consumer sentiment, retail sales and the actions of the retail stocks in the months ahead for clues as to how the economic "tone" of 2001 will begin.  In the last few years, the retailers as a group have rallied from October into the first quarter of each year.  So far this year, no go:

It's now or never for the boomer consumer to pull a rabbit out of the hat.  With the almost 1400 point run in the Dow since the intra-day low a few weeks back, spirits better be bright.  For the sake of the economy, it better translate into retail spending.  In the following two charts, there sure seems to be a direct linkage between the directional movement of the market (the Dow for this example) and consumer confidence.

Romantics are dreaming of a white Christmas.  Retailers are dreaming of a green Christmas.  Will the public deliver something other than a blue Christmas?  For the sake of the new era, they better.

Gimme Credit...Or maybe not.  We find the above discussion regarding retail sales and the economy a bit timely as the Fed released Consumer Credit numbers today for September.  The annual rate of borrowing slowed to 5.2%, one of the lowest levels since April.  (Coincidentally another rotten month for equity returns).  Despite the recent rise in average hourly earnings, quite possibly the slowdown in credit accumulation by the public reflects a few other sobering factors. We have chronicled to you consumer debt growth over the past decade.  Staggering is putting it nicely.  Is the burden finally effecting decision making vis-à-vis consumption?  The wealth effect of the stock market versus the liability of increasing personal debt is working in the wrong direction this year.  Is the market forcing change in personal spending habits?  It may be that a slowing in the overall economy is beginning to be reflected in individual financial behavior.  The ironic twist is that our present economy is so dependent on consumption that a slowing in credit growth may act to put further pressure on economic growth, which will act to further pressure credit growth...  Get the picture?  One month does not a trend make, but it's not too hard to make the leap of faith that the stock market is crucial to the public's feeling of "well being".  The slowing we have experienced during certain months this year in credit growth, retail sales and consumer confidence correlate awfully strongly with coincident bad periods for stocks in general.

Dubya Dubya Dubya.What If I Win?.Com...We've seen boatloads of conjecture regarding "sector picks" based on which candidate wins the election.  Will any one man make a huge difference immediately?  Probably not.  About the only industry we are sure of benefiting regardless of who wins is defense.  It's already a done deal.  Nonetheless, for modern day market participants, it's perceptions and knee-jerk decision making that counts.  Below we present a few charts you may want to keep an eye on in the weeks and months ahead:

We're sure you've all heard the rumors that OPEC, in an effort to discredit the current administration, has purposely kept oil prices high.  It's not OPEC alone that has done this.  Supply and demand factors as well as a below normal inventory situation has helped the cause.  In any event, we have heard it said that OPEC's announced increases in production were only that.  Announcements.  That not a drop of extra oil was produced.  If Bush should win, what better a kick-off party than to have crude drop back to the mid to high twenties in a few months.  The reason we mention this is not only for those in the group to keep a sharp eye on the charts, but the residual effect on the stock market of a potential "cooling off" in oil prices.  No matter where in stocks you are invested or not invested, these charts are important for overall market direction.

The pharmaceuticals have looked right through the "noise" made earlier in the election about Medicare drug purchasing, price caps, etc.  Let's face it, investors have needed a defensive, large cap shelter from the technology storm this year.  Despite the Democratic motto of "do you want this to continue?", we have the distinct impression that Gore will be viewed as anything but pro-business by the foreign community.  That may be where the risk lies if Gore is elected.  Just where do you think the foreign community is long at the moment?  That's right, liquid large cap issues.